US Small Businesses are Experiencing a Mass Extinction Event
65 million years ago an asteroid 10 kilometres across smashed into the earth off the Yucatan peninsula. The initial blast impact was bad enough, but the massive dust clouds and chilling of the climate that followed wiped out a large percentage of species that inhabited our planet.
A similar mass extinction event is taking place today in America and the entities expiring in great numbers are the small businesses that produce a majority of the GDP generated by the private sector and employ nearly half of all US workers. The initial impact was the arrival of COVID-19 to our shores. The dust clouds are our nation’s remarkably poor reaction to the crisis.
This article will attempt to describe 1) what is taking place, 2) how it will change our future if unchecked, and 3) what we will need to do about it.
1) The impact.
We all know that COVID-19 shut down large sectors of our economy even before it became endemic across our nation. The reduction in GDP from March through May crushed those entrepreneurial enterprises that were already in a weakened state. This, in of itself did not represent a systemic crisis as many a small business, like a well-fed dinosaur, could survive lean pickings for a period of time. The real die-off is taking place now as economic activity continues to wither in the face of an explosion of COVID-19 cases across the nation from the beaches of south Florida to the big cities of Texas to the Treasure Valley of Idaho.
The pain is just beginning.
Government efforts have been directed at this crisis with many billions made available through the CARES Act and other legislation. However, it has clearly not been enough and by the middle of May more than 100,000 small businesses had already closed their doors for good. Estimates made then were that fewer than HALF of all small businesses would still be open in December if the pandemic and the affiliated economic crisis continued in excess of four months. We are now hitting the end of the fourth month. Bankruptcy risk is particularly high for companies in face-to-face service industries such as retail trade, leisure, personal grooming, and hospitality which are dominated by enterprises with 500 or fewer employees and employ 20% of all US workers. More recently, Yelp reported that in excess of 70,000 businesses listed on its site had closed for good and that number increased by 15,000 in just the five days ending July 15th. This economic devastation will surely continue to intensify as additional shutdown orders are mandated by state governors across a wide swath of our national geography.
To put these numbers in context, the ‘Great Recession’ led to a peak in business bankruptcies of 61,000 in 2008, and recent years have experienced filings in the 20,000–25,000 range. Of course, most small businesses that close never go through the formal bankruptcy process and according to the US Bureau of Labor Statistics, well over a million small businesses went under in the Great Recession.
Sadly, the negative economic impact of the pandemic is likely to accelerate over the next two months as many struggling enterprises run out of accumulated cash reserves. This process will be driven by the inability of schools to open in most of the nation. States with the youngest populations and the highest percentage of immigrants tend to have the most school-aged children, and unfortunately those also happen to be many of the ones with the worst current COVID-19 outbreaks (Florida, Texas, California, etc.). At-home schooling programs will undoubtedly strain working parents attempting to keep their struggling small businesses afloat. Also, many businesses in ‘college towns’ across the country depend on the return of students in the fall. Sadly, few American co-eds will be back on campus in 2020.
There are almost 60 million small businesses in the United States. We should expect that the majority will survive. However, the Brookings Institute reports that ventures in a large number of commercial activities are at risk of failure. Categories at ‘Immediate Risk’ include a great swath of endeavors ranging from book sellers, to hotels, restaurants, museums, dry cleaners, hardware stores, gas stations, beauty salons, sightseeing transportation, and performing arts. In 2016 the SBA reports that there were more than 2.5 million small businesses in the ‘Retail Trade’ classification with another 1.5 million in the ‘Arts, Entertainment and Recreation’ category. The numbers of firms in trouble add up quickly.
Small businesses cluster where population density is highest, and that means our large cities. For these firms, revenue has plummeted as huge numbers of workers are now working virtually from their homes in the suburbs rather than commuting to their office buildings. Others with the means have relocated out of the cities for the duration of the pandemic. The normal progression of Americans visiting the city for meals, cultural attractions and other entertainment has collapsed. Urban tourism has also seen a massive decline.
If we are very lucky, ‘only’ a similar number of small businesses will go under in 2020–2021 as in the Great Recession. However, if the pandemic continues to rage out of control through the end of the year and the government does not dramatically improve its ability to deliver financial assistance, we could easily see a full 10–15% of small business fail. 6,000,000–9,000,000 business failures by the end of 2021 is a real possibility. Perhaps the toll will be even larger.
This represents a true crisis for the US. To a great extent, our faster growth rate in GDP in recent decades vs. peers in Europe, Canada and Japan can be explained by a regulatory system that allows for more streamlined new company and job creation… and destruction. Without the millions of hard-working small entrepreneurs chasing the dream of financial success, our economy’s ability to grow will be seriously impaired. Shattered dreams lead to anger, derelict commercial zones lead to urban blight, and poverty leads to violence.
2) The fallout.
Even with a rapid drop in the number of COVID-19 cases and distribution of an effective vaccine, the effects of a small business mass extinction event will be severe and long lasting.
The immediate visible effect is that downtown areas across the nation will be littered with small business corpses of boarded up stores, failed restaurants and derelict bars. Repossessed inventories along with surplus vehicles and equipment will flood the market and drive down prices. Unemployment will remain at Depression levels.
Even more important is what such an event will mean for the structure of the American economy.
Large enterprises had many advantages vs. small businesses heading into this economic slowdown: access to the capital markets, more robust internet platforms, and more legal resources to negotiate the reorganization process of the bankruptcy code. The pandemic has made these advantages even greater as government emergency relief programs were structured so as to be much easier for bigger firms to tap. In fact, many giant businesses were able to take advantage of both large AND small company bailout programs at the same time that small enterprises were unable to gain access to either.
Price action in the stock market makes clear that investors believe that small businesses will be disadvantaged in the near future. In the following chart one can see that the S&P 500 Index (SPY) of the largest US companies has significantly outperformed the Russel 2000 (RTY) small cap index. Much worse is the performance of the regional banks index (KRE). These banks are owed billions in loans made to businesses too small to list their shares. Much of this money will never be paid back.
Certainly, small business failures rise at the start of a recession and are guaranteed to stoke the fears of regional bank investors. The problem this time is one of scope with such a large number of industries under pressure. In the Great Recession of 2007–2009 the pain was severe but still generally confined to the housing market and finance. The downturn in 2001 after the ‘dot com’ crash exposed overinvestment in the telecom and technology sectors. The COVID-19 Depression is causing much more stress: restaurants, hotels, ground transportation, education, retail, petroleum distribution, health care, entertainment, regional banking and real estate are all suffering.
If a significant percentage of small businesses close their doors for good, that will increase the political, economic and social power of big businesses. Of course, even before the pandemic, the internet and smart phones had already been causing havoc among many millions of small enterprises and concentrating power at the largest companies. Technologically adept enterprises such as Amazon, Uber, eBay, Yelp, Etsy, Google and Grubhub were disintermediating sectors as diverse as toys, clothing, taxi service, books and food delivery well before 2020. The issue is that a process which was taking place at a speed which allowed many small businesses to evolve and compete has now accelerated. A large segment of the population (the elderly, those with comorbidities to COVID-19, etc.) have shifted their buying habits to the web and would not currently visit small business establishments even if they were open.
A recession severely damaging to much of the entrepreneurial landscape is likely to be one that lasts longer and does more damage to the US economy. While the current downturn already looks to be one that will be more severe than American have experienced since 1945, it is particularly unusual in that each month the pandemic suppresses business activity, the worse the pain will be and the longer it will be until for the economy recovers.
· Small businesses are faster to hire and expand than larger competitors. Of course, failed entrepreneurial ventures do not expand nor hire staff.
· After regional banks are forced to charge off large numbers of loans from a sector, they show that much more pusillanimity extending credit to businesses in that area. A dearth of start-up and growth capital for small enterprises would act as a headwind for any economic recovery.
· In contrast to small companies, large corporations experiencing a loss of competitors often find themselves in oligopolistic or even monopolistic market positions. This encourages raising prices and lowering product quality to maximize profits at the cost of revenue expansion and results in a drag on GDP growth.
· Successful small business owners are much more likely to deploy their capital into growth-oriented investments than larger public companies focused on quarterly results. As many entrepreneurs see their life’s savings wiped out in this downturn, capital formation across the economy will be diminished and slow the recovery in GDP.
Unfortunately, the current economic recession is likely to be more akin to what took place in the 1930s than what we have come to experience in the post-war period: severe in scope, extended in duration, exacerbating economic inequality and casting a significant pall over national optimism as well as belief in the ‘American Dream’.
3) Policy Prescriptions
It is obvious, but worth repeating that the US economy will not recover while the pandemic rages across the nation. States, cities, and industries can not simply ‘open-up’ or be ‘liberated’ if such action simply lead to a greater number of COVID-19 cases which then result in more retrenchment in economic activity. Sadly, tragically, it seems that we currently do not possess the national will and leadership required to suppress the pandemic successfully within our borders.
Thus, we may have to wait until a vaccine or effective therapeutic is developed and distributed before we reach the bottom of the ‘V’ or ‘U’ of this economic recession. That does not mean we should not consider changes in policy today to heal our nation that can attract bipartisan support. Actions to consider include the following:
· Current and additional governmental financial support programs must focus business assistance towards true small companies. This means limiting loans or grants to firms not affiliated with larger organizations with interlocking ownership structures. This will be money well spent as small businesses that survive an economic downturn grow faster and expand their hiring more quickly than larger entities.
· Many regional banks will suffer large loan losses due to the COVID-19 downturn. When the economy bottoms, growth capital for smaller businesses will be in short supply. An increase in budget for SBA loans should be prepared now. Again, such assistance should not be directed to what are actually subsidiaries of large companies. Such additional government loans will likely perform well as many new ventures will simply be recapitalized formerly successful business such as those in the restaurant, personal grooming, and hospitality sectors that retain excellent locations, client lists and brand equity.
· The middle of a pandemic and an economic disaster is not the time to consider use of anti-trust legislation. However, we should start dusting off the Sherman Antitrust Act, the Clayton Act and the Federal Trade Commission Act now. Accumulation of market power and rising economic inequality go hand in hand across our nation’s history. The pandemic and current government assistance programs are accelerating the recent trend of a shrinking number of companies exercising oligopolistic or even monopolistic positions in many business sectors formerly dominated by small competitors. Judicious use of such laws will pay rich dividends for society as unregulated monopolies have been shown to suppress overall economic growth due to their focus on short-term profit maximization.
· Some level of student debt must be extinguished for those who borrowed money from the Federal Government but had their studies interrupted. For those students in certain fields likely to start a small business, an additional layer of borrowing will retard the rate at which new companies are founded and have a negative knock on effect for GDP growth and employment levels.
· Many city commercial districts are likely to be particularly severely impacted by the ongoing crisis. Creating additional enterprise zones where tax breaks and regulations are relaxed will reduce the chance of urban blight in these areas.
· Certain business sectors have seen a dramatic increase in demand and revenue because of the COVID-19 crisis. These include, but are not limited to, food delivery aggregators, for-profit online education firms, ecommerce marketplaces, video conferencing, and recreational vehicle manufacturers. Some of these windfall profits could be taxed to help provide aid to the rest of the economy.
We can hope that an effective vaccine or cure for COVID-19 is found before the end of 2020 which can be manufactured in bulk and distributed across our population. However, hope is not a strategy and we need to plan today to mitigate the fallout of what is likely to be a severe and lengthy economic retrenchment. Doing nothing will lead to a slower economic recovery, an increase in large company dominance in many economic sectors, and rising income inequality. We should prepare now to alleviate these negative events before it is too late.
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